Reconciliation: The Transaction Challenge For Financial Institutions
Reconciliation of transactions is one of the critical operations in every financial institution and the effective management of this activity is essential to the success of an organisation. The main objective of performing reconciliation is to identify incompatibilities in data and achieve resolution.
Reconciliation is an important function in the areas of cash management, payment processing, GL accounting, pre- and post- trade settlement, position management, confirmations and risk and compliance management.
Timely bank reconciliation would allow effective management of payables and receivables thereby enabling timely management for optimum utilisation of cash. This includes identification of suitable opportunities to capture revenue and more efficient use of cash resources.
Uniform Commercial Code regulates all the activities between the client and the business institution. It expects the business clients to notify their banks of any statement discrepancies that may point to an error or fraud. The account holder/client lose the rights to claim in case of any errors in their financial statement. Proper reconciliation management might help identify possible process gaps and rectification of the same.
Reconciliation acts as one of the means in achieving the goal of risk management that is protection of corporate assets and minimisation of losses. Highest priority is given to exceptions arising out of reconciliation process, which could lead to cash loss by the organisation. Effective reconciliation process also avoids any unwanted reputation loss to the organisation through timely settlement.
Proper bank reconciliation helps banks in spotting unusual and suspicious banking activities like deposits recurring at a particular period of time in the customer accounts, wire transfers in huge sums from overseas accounts, etc. With a prior knowledge about customers with KYC policy, banks may be able to spot fraudulent activity.
Front office operations include trade order management, capture and execution, deal structuring, data reception and distribution, pre-trade compliance, portfolio analytics, etc. Scope for reconciliation comes in the trade validation process wherein the structure of the agreed trade is checked against the corresponding booking into the front office system. Daily reconciliation process is executed to ensure the matching of front and back office records to sort discrepancies arising out of manual error during input.
Middle office operations include risk management, position management, post-trade compliance, settlement and trade matching:
Back office operations include confirmation, profit and loss (P&L) calculation, trade inventory, custodian services, collateral management, transfer agency, client reporting:
Currently, financial institutions and investment banks face the challenge of ever increasing volumes of trade transactions to be reconciled and the complexity of new instruments coupled with regulatory compliance demands and also the need to reduce the inefficiencies in their operations.
The need to reduce manual errors during reconciliation is of utmost importance to reduce potential operational risk and thereby minimise operational cost without hindrance to the normal processes.
Achievement of consistency in trade processing, data management, accounting to comply with standards, clearance and settlement, control and compliance should be able to define an integrated process flow management within an organisation.
Another major challenge facing the reconciliation analysis is the emergence of new asset types and structured deals with more complex technicalities and calculations involved, which would require modification/improvement of existing systems to accommodate reconciliation of such complex and diversified deals.
The traditional approach is manual reconciliation, which is still being followed in many financial institutions. In this approach, the records are manually entered, compared, analysed and the exceptions are stored separately. Manual process is more tiresome because of increasing volumes of the data. This may also be prone to more errors.
The tool-based approach overcomes important challenges and drawbacks that can be found in the traditional reconciliation approach. Through automation, errors due to manual reconciliation can be greatly reduced. The outcomes will be more efficient and faster with integrated exception handling. For instance, the ideal reconciliation process should be able to link the order management system and payment system to automate reconciliation process and engage manpower for exception handling, which would require analytical skills according to the type of discrepancy involved. This situation provides the ideal platform for financial institutions to engage skilled staff in resolving complex discrepancies and real-time reporting of cash flow positions and appropriate actions to minimise operational losses.
In the tool-based approach, exceptions can automatically generate queries and correspondence to be passed to internal/external counterparties via SWIFT, mail or fax and subsequent chasers or overdue reports prompts processors and management to keep effective control of the process. Some benefits of the tool-based approach include:
Financial institutions’ processes, whether related to banking or trading, are undergoing new changes with an unprecedented increase of transaction volumes and a corresponding expansion in market information. This brings the need of effective data management solutions in the areas of reconciliation in order to have smooth ongoing operations. Demand for reconciliation solutions with optimum speed and performance coupled with uncompromising levels of accuracy, controls and data management is the foremost requirement for customer satisfaction. Financial institutions are envisaging an automated and integrated approach rather than a traditional approach.